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Financial Meltdown: The Greatest Transfer of Wealth in

History
How to Reverse the Tide and Democratize the US Monetary
System

By Ellen Brown

Global Research, October 17, 2008

author's website: webofdebt.com

"Admit it, mes amis, the rugged individualism and cutthroat capitalism that
made America the land of unlimited opportunity has been shrink-wrapped by
half a dozen short sellers in Greenwich, Conn., and FedExed to Washington,
D.C., to be spoon-fed back to life by Fed Chairman Ben Bernanke and
Treasury Secretary Hank Paulson. We’re now no different from any of those
Western European semi-socialist welfare states that we love to deride."– Bill
Saporito, "How We Became the United States of France," Time (September 21,
2008)

On October 15, the Presidential candidates had their last debate before the election. They
talked of the baleful state of the economy and the stock market; but omitted from the
discussion was what actually caused the credit freeze, and whether the banks should be
nationalized as Treasury Secretary Hank Paulson is now proceeding to do. The omission was
probably excusable, since the financial landscape has been changing so fast that it is hard to
keep up. A year ago, the Dow Jones Industrial Average broke through 14,000 to make a new
all-time high. Anyone predicting then that a year later the Dow would drop nearly by half and
the Treasury would move to nationalize the banks would have been regarded with amused
disbelief. But that is where we are today.1

Congress hastily voted to approve Treasury Secretary Hank Paulson’s $700 billion bank bailout
plan on October 3, 2008, after a tumultuous week in which the Dow fell dangerously near the
critical 10,000 level. The market, however, was not assuaged. The Dow proceeded to break
through not only 10,000 but then 9,000 and 8,000, closing at 8,451 on Friday, October 10.
The week was called the worst in U.S. stock market history.

On Monday, October 13, the market staged a comeback the likes of which had not been seen
since 1933, rising a full 11% in one day. This happened after the government announced a
plan to buy equity interests in key banks, partially nationalizing them; and the Federal
Reserve led a push to flood the global financial system with dollars.

The reversal was dramatic but short-lived. On October 15, the day of the Presidential debate,
the Dow dropped 733 points, crash landing at 8,578. The reversal is looking more like a
massive pump and dump scheme – artificially inflating the market so insiders can get out –
than a true economic rescue. The real problem is not in the much-discussed subprime market
but is in the credit market, which has dried up. The banking scheme itself has failed. As was
learned by painful experience during the Great Depression, the economy cannot be rescued by
simply propping up failed banks. The banking system itself needs to be overhauled.
A Litany of Failed Rescue Plans

Credit has dried up because many banks cannot meet the 8% capital requirement that limits
their ability to lend. A bank’s capital – the money it gets from the sale of stock or from profits
– can be fanned into more than 10 times its value in loans; but this leverage also works the
other way. While $80 in capital can produce $1,000 in loans, an $80 loss from default wipes
out $80 in capital, reducing the sum that can be lent by $1,000. Since the banks have been
experiencing widespread loan defaults, their capital base has shrunk proportionately.

The bank bailout plan announced on October 3 involved using taxpayer money to buy up
mortgage-related securities from troubled banks. This was supposed to reduce the need for
new capital by reducing the amount of risky assets on the banks’ books. But the banks’ risky
assets include derivatives – speculative bets on market changes – and derivative exposure for
U.S. banks is now estimated at a breathtaking $180 trillion.2 The sum represents an
impossible-to-fill black hole that is three times the gross domestic product of all the countries
in the world combined. As one critic said of Paulson’s roundabout bailout plan, "this seems
designed to help Hank’s friends offload trash, more than to clear a market blockage."3

By Thursday, October 9, Paulson himself evidently had doubts about his ability to sell the plan.
He wasn’t abandoning his old cronies, but he soft-pedaled that plan in favor of another option
buried in the voluminous rescue package – using a portion of the $700 billion to buy stock in
the banks directly. Plan B represented a controversial move toward nationalization, but it was
an improvement over Plan A, which would have reduced capital requirements only by the
value of the bad debts shifted onto the government’s books. In Plan B, the money would be
spent on bank stock, increasing the banks’ capital base, which could then be leveraged into
ten times that sum in loans. The plan was an improvement but the market was evidently not
convinced, since the Dow proceeded to drop another thousand points from Thursday’s opening
to Friday’s close.

One problem with Plan B was that it did not really mean nationalization (public ownership and
control of the participating banks). Rather, it came closer to what has been called "crony
capitalism" or "corporate welfare." The bank stock being bought would be non-voting preferred
stock, meaning the government would have no say in how the bank was run. The Treasury
would just be feeding the bank money to do with as it would. Management could continue to
collect enormous salaries while investing in wildly speculative ventures with the taxpayers’
money. The banks could not be forced to use the money to make much-needed loans but
could just use it to clean up their derivative-infested balance sheets. In the end, the banks
were still liable to go bankrupt, wiping out the taxpayers’ investment altogether. Even if $700
billion were fanned into $7 trillion, the sum would not come close to removing the $180 trillion
in derivative liabilities from the banks’ books. Shifting those liabilities onto the public purse
would just empty the purse without filling the derivative black hole.

Plan C, the plan du jour, does impose some limits on management compensation. But the
more significant feature of this week’s plan is the Fed’s new "Commercial Paper Funding
Facility," which is slated to be operational on October 27, 2008. The facility would open the
Fed’s lending window for short-term commercial paper, the money corporations need to fund
their day-to-day business operations. On October 14, the Federal Reserve Bank of New York
justified this extraordinary expansion of its lending powers by stating:

"The CPFF is authorized under Section 13(3) of the Federal Reserve Act, which
permits the Board, in unusual and exigent circumstances, to authorize Reserve
Banks to extend credit to individuals, partnerships, and corporations that are
unable to obtain adequate credit accommodations. . . .

"The U.S. Treasury believes this facility is necessary to prevent substantial


disruptions to the financial markets and the economy and will make a special
deposit at the New York Fed in support of this facility."4

That means the government and the Fed are now committing even more public money and
taking on even more public risk. The taxpayers are already tapped out, so the Treasury’s
"special deposit" will no doubt come from U.S. bonds, meaning more debt on which the
taxpayers have to pay interest. The federal debt could wind up running so high that the
government loses its own triple-A rating. The U.S. could be reduced to Third World status,
with "austerity measures" being imposed as a condition for further loans, and hyperinflation
running the dollar into oblivion. Rather than solving the problem, these "rescue" plans seem
destined to make it worse.

The Collapse of a 300 Year Ponzi Scheme

All the king’s men cannot put the private banking system together again, for the simple reason
that it is a Ponzi scheme that has reached its mathematical limits. A Ponzi scheme is a form of
pyramid scheme in which new investors must continually be sucked in at the bottom to
support the investors at the top. In this case, new borrowers must continually be sucked in to
support the creditors at the top. The Wall Street Ponzi scheme is built on "fractional reserve"
lending, which allows banks to create "credit" (or "debt") with accounting entries. Banks are
now allowed to lend from 10 to 30 times their "reserves," essentially counterfeiting the money
they lend. Over 97 percent of the U.S. money supply (M3) has been created by banks in this
way.5 The problem is that banks create only the principal and not the interest necessary to
pay back their loans. Since bank lending is essentially the only source of new money in the
system, someone somewhere must continually be taking out new loans just to create enough
"money" (or "credit") to service the old loans composing the money supply. This spiraling
interest problem and the need to find new debtors has gone on for over 300 years -- ever
since the founding of the Bank of England in 1694 – until the whole world has now become
mired in debt to the bankers’ private money monopoly. As British financial analyst Chris Cook
observes:

"Exponential economic growth required by the mathematics of compound


interest on a money supply based on money as debt must always run up
eventually against the finite nature of Earth’s resources."6

The parasite has finally run out of its food source. But the crisis is not in the economy itself,
which is fundamentally sound – or would be with a proper credit system to oil the wheels of
production. The crisis is in the banking system, which can no longer cover up the shell game it
has played for three centuries with other people’s money. Fortunately, we don’t need the
credit of private banks. A sovereign government can create its own.

The New Deal Revisited

Today’s credit crisis is very similar to that facing Franklin Roosevelt in the 1930s. In 1932,
President Hoover set up the Reconstruction Finance Corporation (RFC) as a federally-owned
bank that would bail out commercial banks by extending loans to them, much as the privately-
owned Federal Reserve is doing today. But like today, Hoover’s plan failed. The banks did not
need more loans; they were already drowning in debt. They needed customers with money to
spend and to invest. President Roosevelt used Hoover’s new government-owned lending
facility to extend loans where they were needed most – for housing, agriculture and industry.
Many new federal agencies were set up and funded by the RFC, including the HOLC (Home
Owners Loan Corporation) and Fannie Mae (the Federal National Mortgage Association, which
was then a government-owned agency). In the 1940s, the RFC went into overdrive funding
the infrastructure necessary for the U.S. to participate in World War II, setting the country up
with the infrastructure it needed to become the world’s industrial leader after the war.

The RFC was a government-owned bank that sidestepped the privately-owned Federal
Reserve; but unlike the private banks with which it was competing, the RFC had to have the
money in hand before lending it. The RFC was funded by issuing government bonds (I.O.U.s or
debt) and relending the proceeds. The result was to put the taxpayers further into debt. This
problem could be avoided, however, by updating the RFC model. A system of public banks
might be set up that had the power to create credit themselves, just as private banks do now.
A public bank operating on the private bank model could fan $700 billion in capital reserves
into $7 trillion in public credit that was derivative-free, liability-free, and readily available to
fund all those things we think we don’t have the money for now, including the loans necessary
to meet payrolls, fund mortgages, and underwrite public infrastructure.

Credit as a Public Utility

"Credit" can and should be a national utility, a public service provided by the government to
the people it serves. Many people are opposed to getting the government involved in the
banking system, but the fact is that the government is already involved. A modern-day RFC
would actually mean less government involvement and a more efficient use of the already-
earmarked $700 billion than policymakers are talking about now. The government would not
need to interfere with the private banking system, which could carry on as before. The
Treasury would not need to bail out the banks, which could be left to those same free market
forces that have served them so well up to now. If banks went bankrupt, they could be put
into FDIC receivership and nationalized. The government would then own a string of banks,
which could be used to service the depository and credit needs of the community. There would
be no need to change the personnel or procedures of these newly-nationalized banks. They
could engage in "fractional reserve" lending just as they do now. The only difference would be
that the interest on loans would return to the government, helping to defray the tax burden on
the populace; and the banks would start out with a clean set of books, so their $700 billion in
startup capital could be fanned into $7 trillion in new loans. This was the sort of banking
scheme used in Benjamin Franklin’s colony of Pennsylvania, where it worked brilliantly well.
The spiraling-interest problem was avoided by printing some extra money and spending it into
the economy for public purposes. During the decades the provincial bank operated, the
Pennsylvania colonists paid no taxes, there was no government debt, and inflation did not
result.7

Like the Pennsylvania bank, a modern-day federal banking system would not actually need
"reserves" at all. It is the sovereign right of a government to issue the currency of the realm.
What backs our money today is simply "the full faith and credit of the United States,"
something the United States should be able to issue directly without having to draw on
"reserves" of its own credit. But if Congress is not prepared to go that far, a more efficient use
of the earmarked $700 billion than bailing out failing banks would be to designate the funds as
the "reserves" for a newly-reconstituted RFC.

Rather than creating a separate public banking corporation called the RFC, the nation’s
financial apparatus could be streamlined by simply nationalizing the privately-owned Federal
Reserve; but again, Congress may not be prepared to go that far. Since there is already
successful precedent for establishing an RFC in times like these, that model could serve as a
non-controversial starting point for a new public credit facility. The G-7 nations’ financial
planners, who met in Washington D.C. this past weekend, appear intent on supporting the
banking system with enough government-debt-backed "liquidity" to produce what Jim Rogers
calls "an inflationary holocaust." As the U.S. private banking system self-destructs, we need to
ensure that a public credit system is in place and ready to serve the people’s needs in its
stead.
Ellen Brown, J.D., developed her research skills as an attorney practicing civil litigation in Los
Angeles. In Web of Debt, her latest book, she turns those skills to an analysis of the Federal
Reserve and "the money trust." She shows how this private cartel has usurped the power to
create money from the people themselves, and how we the people can get it back. Her eleven
books include the bestselling Nature’s Pharmacy, co-authored with Dr. Lynne Walker, and
Forbidden Medicine. Her websites are www.webofdebt.com and www.ellenbrown.com.

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